With the US presidential election out of the way, markets refocused their attention to the looming fiscal uncertainty south of the border and to debt woes in the euro zone.

On both counts, the picture wasn’t pretty. The US$600 billion or so in spending cuts and tax increases that go into effect at year’s end – known as the fiscal cliff – are expected to shrink GDP numbers and potentially push the country into recession according to a non-partisan Congressional Budget Office report. The solution – a negotiated political agreement between The White House and Congress – is what’s got investors on edge. The two sides have a poor track record when it comes to working together as illustrated by the not-so-long-ago debt ceiling debate which remained deadlocked until the last minute. It’s feared a similar situation will play out with the fiscal cliff as many Republicans may resist any proposal that can be viewed as raising taxes while many Democrats may refuse to ratchet down entitlement programs and engage in spending cuts. The worries over fiscal uncertainty overshadowed economic data releases this week including a solid labour market report Thursday and a better-than-expected read on exports.

Meantime in the euro zone, the European Commission forecasted Wednesday that 2013 growth among the 17-member currency union would fall to .4% while the larger 27-member union would drop to just .1%. With near-zero growth it will become even more difficult to service the crushing debt weighing on much of Europe, which further heightened market nervousness. Also in Europe, Greeks took to the streets mid-week protesting multi-billion euro cuts made necessary to win more bailout funds. Look for further protests in advance of Sunday when Greece’s Parliament must approve the 2013 budget. Finally, the transition to new leadership in Beijing got underway Thursday. The degree to which China is heading for meaningful change will become apparent in seven days when we get to see the make-up of the new Politburo Standing Committee.

The TSX fell 189 pts. over the four-day period to close at 12,191. New York markets fell considerably more and the ytd performance gap between the two countries’ most recognized indexes continues to narrow. Through to close Thursday, the Dow lost 282 pts. to close at 12,811, the S&P 500 shed 37pts. to finish at 1,377 and the Nasdaq shed 87pts. to end at 2,895.

Our Recommendation

Data supports adding to equities

Equities. Steve Uzielli, Director, Portfolio Advisory Group (PAG) wrote: “while we are advocating a preference for cyclicals over defensive stocks, this is in the context of a well-diversified, balanced portfolio which also includes defensive, dividend paying securities. We believe at the margin however, shares of more economically sensitive companies will outperform within the framework of an improving economic outlook which leads to higher industrial commodity prices.”

Fixed income. Andrew Mystic, Associate Director, PAG, suggests “given the Bank of Canada’s recent tone, advisors should begin to re-evaluate the duration of their portfolios - particularly given the relatively low rate environment and its potential impact on value if rates reverse course.”

Portfolio strategy. Scotiabank GBM Portfolio Strategist Vincent Delisle says: “notwithstanding the risks tied to a messy fiscal deal in Washington, we see a major disconnect between recent US macro momentum and sentiment.”

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